​At The IIA's recent General Audit Management conference, the leader of a group representing corporate directors characterized investor activism as one of the main things that keep them up at night. Indeed, Peter Gleason, National Association of Corporate Directors president, told attendees that for directors this concern ranked second only to cyberattacks.

​This revelation generated considerable discussion at The IIA's global headquarters about where internal audit fits into the issue. In the eyes of our stakeholders, investor activism is a substantial risk; yet rarely, if ever, does it show up on internal audit's radar.

Let's look at why this issue generates so many sleepless nights for corporate directors. The image of the activist investor typically takes on two caricature forms. One is the annoying fixture at annual meetings whose rants are politely listened to and ignored. The other is the specter of a well-financed and charismatic Gordon Gekko-like corporate raider who swoops in and takes over the annual meeting.

A more accurate description of today's activist investor is an individual or group who buy enough shares of a corporation to demand representation on the board while pushing for changes they believe will benefit shareholders, including themselves.

Two recent examples show that the outcomes of investor activism can vary widely. Beauty products retailer Avon Products recently succumbed to pressure from activist investors, agreeing to allow Barington Capital Group to appoint an independent director to the corporation's board. Meanwhile, Yahoo is battling with Starboard Value, the activist investor who announced it would seek to replace the entire Yahoo board. Starboard announced it is nominating nine new board candidates, including Starboard's CEO.

It remains to be seen how the Yahoo situation will play out, but such wholesale takeover bids are rare. While they can still happen, the activist investor strategy of today typically is driven by identifying corporations with undervalued stock and agitating for changes they believe will boost the stock's value. Despite the Yahoo example, it is typically less about gaining control of a company than improving the bottom line.

The impact of investor activism is clearly growing. A report by attorneys at the global law firm Davis Polk & Wardwell found hedge funds embarked on 230 activist campaigns in 2015. The most telling finding in the report reveals that the average time between activists unveiling their stake in a corporation to a settlement announcement was 56 days in 2015, a 24 percent drop since 2013.

So where does internal audit fit in? The most obvious answer is that it should be continuously providing assurance on practices and processes that avoid conditions that make corporations vulnerable to activist investors.

Companies can reduce the risk of becoming easy targets by deploying effective business strategies, and processes that ensure good governance and position the business for sustained growth of shareholder value. Undervalued stock, mismanagement, excessive costs, or low profits – conditions that make a corporation a prime target for activist investors – likely are symptoms of risk failures elsewhere.

Chief audit executives of publicly traded companies must be especially attuned to conditions that might make them vulnerable to activist investors on a number of levels. A few areas of focus include:

Basic good governance – Is the company following basic good governance practices? In 2015, several high-profile publicly traded companies admitted to major breakdowns in governance that led to financial restatements and wholesale management changes.

Risk management – Has the company deployed an effective risk management framework? Has the board been engaged in setting the risk appetite, and is management identifying, assessing, and monitoring risks on a continuous basis?

Executive compensation – How does the company's compensation structure compare to others in the same industry? If your company is an outlier on the high end, it may be vulnerable to activist investors.

Performance – How is the company performing against competitors? Are management actions in response to competition endangering or undermining good governance practices?

Each of these areas should be familiar to heads of audit as part of basic operational and financial risks that often fall within internal audit's purview.

Navigating questions about management's or the board's direction, motivations, or competence is clearly a bigger challenge that must be addressed delicately and strategically. While internal audit should never be in a position to dictate who operates in the C-suite or serves on the board, it can be in a position to influence, advise, and counsel corporate boards and management about vulnerabilities created by weak or misguided leadership.

Additionally, because weakness or vulnerability to investor activism often lie in flawed or poorly executed processes, internal audit can press to provide oversight, assurance, and insights on business strategies and processes at the highest levels.

Heads of audit also must be attuned to management and board actions in response to activist investors. The internal audit function may come under pressure to delay execution or reporting on engagements that might reflect badly on management or confirm criticisms from activist investors.

In those cases, chief audit executives must be courageous and remain committed to providing objective, independent, and risk-based assurance no matter how it may impact activist investors' efforts.

The opinions expressed by Internal Auditor’s bloggers may differ from policies and official statements of The Institute of Internal Auditors and its committees and from opinions endorsed by the bloggers' employers or the editors of Internal Auditor. The magazine is pleased to provide you an opportunity to share your thoughts about these blog posts. Some comments may be reprinted elsewhere, online or offline.

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